Economist, Dr. Tom Skladzien, writes about quantitative easing and explores alternatives for economic stimulus
Since the Global Financial Crisis, or what is called the Great Recession in the rest of the developed world, advanced economies from Australia to the EU and US haven’t seen the quick recovery that we’ve been taught to expect follows a recession as surely as night follows day.
Instead, the developed world has seen under performing growth, increased inequality, investment into financial and existing assets (rather than new productive assets), and very low inflation and increasingly deflation. Coupled with stagnating median wages, increased insecure work, an increasing infrastructure gap, near zero (or in some cases negative) interest rates and now a slowing developing world economy, it’s no wonder that those arguing economic stagnation rather than growth is the new normal are growing in number and gaining in credibility.
While such pessimism is misplaced, there’s no doubt we do now live in a new economic world; one that academic economists let alone policy makers are yet to fully grasp. The much celebrated “Great Moderation”, which promised a stable, prosperous and boring economic future has been exposed as cods-wallop, just as the better known End of History proclaimed by Francis Fukuyama which promised a stable, peaceful and boring geo-political future has been exposed as bolder-dash. For better or worse, both politics and economics are proving to be more interesting than many expected following the end of the Cold War.
On the economic front, without being excessively pessimistic or alarmist, we can safely say our current economic challenges are stretching the consensus about the effectiveness and use of both fiscal and monetary macro-economic policy. Rather than a dramatic crisis of growth, we’re seeing persistent and growing stagnation; in growth, in incomes and wages and in prices. Rather than a frog being thrown into a boiling pot of water type crisis, we’re a frog sitting in a warm pot while the temperature keeps rising. In this context, both traditional fiscal and monetary policy are failing to turn the heat down and get us back to what we not long ago considered a normal growth path.
There’s no doubt most of the causes of this growing stagnation are deep and historical economic changes, with rising inequality being both a cause and a symptom of our challenges. Underinvestment in infrastructure, excessive financialisation and skewed investment incentives, a lack of equitable investment in education and training, excessive corporate concentration and market power, a lack of research and industry collaboration, diminished worker’s rights and bargaining power; these and other factors no doubt play a large role in the stagnation we’re struggling with, both at home and abroad. But these deeper factors don’t relieve fiscal and monetary policy makers from an obligation to do what they can to improve incomes and growth. If these policymakers can’t act in a way that’s seen to be at least partially effective, then no only will the economy fail to improve, but confidence in both our politics and our economy will continue to deteriorate, compounding our challenges. For this reason alone, it is crucial these policies are as effective as possible.
Both overseas and in Australia, we’ve seen traditional fiscal policy fall out of favor as public debt levels have grown and governments have perceived tightening fiscal constraints, leading to efforts to cut spending – otherwise known as austerity, rather than stimulus policies to support growth. While economists are divided about the validity of perceived fiscal constraints, with many arguing these constraints are overblown especially in a world of record low interest rates, few governments are willing to take on this advice and fiscal austerity rather then stimulus remains the dominant approach to policy. This certainly holds true in Australia, even though our public debt levels remain low by international standards.
Both sides of the political spectrum are focused on a return to surplus, with Labor taking a longer term structural approach to improving the budget that allows for higher spending and investment in the short term, but significant structural improvement in the longer term. Largely through improving the progressivity of the tax system through reforms to negative gearing and other taxes, Labor aims to put the budget on a sustainable long term footing; a policy both sound and overdue. On the other hand, the Coalition Government remains committed to severe short term cuts in spending and counter productively, to longer term corporate and high end income tax cuts which make the structural budgetary position significantly worse in the longer term. In effect, the Coalition plan is the exact opposite of what sensible management calls for; short term austerity and long term irresponsibility. Either way, to expect either party to embrace significant fiscal stimulus in the short term isn’t realistic, which places the responsibility for any macro-economic stimulus in the short term squarely with the RBA and monetary policy, a situation many countries have come to before us, most notably the USA, UK and Japan.
Like in other advanced countries, Australia is fast approaching the end of effective traditional monetary policy. As has already happened in the USA, Japan and through large parts of Europe, official interest rate cuts are reaching their limit as rates approach zero. Australia’s ‘cash rate’ is currently 1.75 per cent and is expected to be cut again sooner rather than later. This is already the lowest cash rate in our history and it is already barely above zero in any meaningful sense.
Overseas, as central banks have come up against the limits of traditional interest rate targeting monetary policy, they have engaged in what has come to be known as Quantitative Easing (QE). QE policy creates new money and injects it into the economy via asset purchases from financial intermediaries like banks. The hope being that this lowers longer term interest rates and fuels more lending, consumption and investment in the economy, boosting output and incomes. In the simplest terms, QE is a policy that prints money and gives it to the financial system, hoping it will somehow trickle down to the real economy and find its way to fueling real new investment and ultimately into ordinary people’s pockets. Its results have been mixed at best.
While there is little doubt QE has supported economies and mitigated the extent of recessions overseas, there is also little doubt QE has contributed to rising inequality and has led to massive cash reserves in banks and the broader corporate sector. Crucially, QE has failed to significantly increase productive investment which grows jobs and ordinary incomes, instead inflating existing asset prices, including stock prices, which overwhelmingly benefit the rich while ordinary people, small businesses and the real economy continue to struggle.
Having seen the mixed and far from ideal results of QE overseas, it is clear that should further stimulus be needed in Australia, as seems almost a certainty, we should not follow others down the standard QE path. This is especially the case since QE has not only been ineffective in supporting a return to more sustainable growth, but because it exacerbates rather than improves the underlying problem of growing income and wealth inequality.
Other alternatives do exist and are preferable to Australian QE, but they can only be implemented if the RBA acknowledges the three simultaneous truths of; the obvious flaws of QE, the lack of political will for traditional fiscal stimulus, and the economic need (and expectation) for macro-economic stimulus. The simultaneous recognition of these three truths can only lead to an RBA lead non-traditional expansionary policy.
The most commonly mentioned and broadly supported alternative to QE is “helicopter money”, usually interpreted to mean the direct injection of newly created money into consumer’s pockets, rather than financial institutions. This would be a direct stimulus to demand, it would directly help struggling families and workers and it would not have the inequality fueling effects of QE. In addition, even though it more resembles a fiscal stimulus in its effects, it would not require any institutional change in the relationship between monetary policy and fiscal policy, it would not affect the government’s budget or debt position and it would not impinge on central bank independence. The main draw back of such a policy is that it would not address any underlying causes of stagnation, such as underinvestment in infrastructure, but it would still be a massive improvement on standard QE policy.
Another class of alternative policy is ‘people’s QE’ (PQE) which has many proposed variations and interpretations, but is effectively a more explicit hybrid between QE and traditional fiscal policy. With PQE, fiscal investment, whether in productive infrastructure, housing or other destinations, is financed by new money creation, effectively representing what can be called monetarized fiscal stimulus. The obvious benefit of PQE is stimulus is not only directed to directly improving current demand buy the building of projects, but if used to finance genuine infrastructure shortfalls, it serves to improve the economy’s productive capacity, productivity and longer term prospects. However, such an approach raises serious questions about central bank independence as well as concerns about how worthwhile investments are to be identified and prioritised. It effectively requires at least some coordination between fiscal and monetary authorities, opening a proverbial can of worms that flies in the face of decades of consensus about how fiscal and monetary policy should and should not interact.
To make such a policy credible and effective, strong safeguards for RBA independence would need to be ensured while the government would also need to ensure projects are chosen based purely on grounds of economic benefit. In addition, given extremely low borrowing costs for government and the complications of a PQE policy, many will credibly argue that the political will required to implement PQE is actually less than that required to implement more standard fiscal stimulus through infrastructure investment financed by long term borrowing at historically low rates. Alternatively, given PQE would effectively isolate infrastructure investment from the federal budget, there is a chance a government would see it as a workable option around perceived fiscal constraints, even if those constraints are more perceived than real.
While Australia has very strong and well regarded economic institutions, and we are relatively well placed to make PQE work, on balance it is a policy that would be difficult to implement, not least due to the need for government as well as RBA support for a novel policy approach. As such, it seems unlikely, even if ideal given the political and other constraints we face.
The economic stagnation we’re facing and its likely deepening means policy makers, and all who are interested in policy, should continue to think out of the box. Circumstances and excellent economic management by the previous Labor Government have meant we in Australia have had more time to see the effects of novel macro-economic policy overseas before needing to resort to novel policy ourselves. We should benefit from this and learn from the experiences and mistakes of others. Standard QE is one such mistake and while it is unlikely we will be able to implement an alternative that addresses longer term economic challenges as well as the need for short term stimulus, we should certainly be able to implement an alternative that doesn’t exacerbate these challenges, as QE certainly does with its impact on inequality. We can certainly improve on standard QE. Like so much else, it is only an issue of will and courage.